Military contractors' epic overcharging

The government needs to know the true cost of the products it's purchasing to avoid getting fleeced by unscrupulous suppliers

A soldier being inoculated for anthrax in 2000. The Pentagon has paid the manufacturer of BioThrax $1.3bn, for a vaccine that an independent report calculates cost only $250m to produce. Photograph: AP/Dave Bowman
Dave Bowman/AP

An anthrax vaccine of contested quality has paid out over $1bn in profit to a small company in Maryland, despite the fact that the company neither invented the product nor built the production facilities. A new report by Scott Lilly, my colleague at the Centre for American Progress in Washington, has the details: Emergent BioSolutions has billed the Pentagon $1.3bn for BioThrax, which he calculates cost the company roughly just $250m to manufacture. Lilly comments:

"It is hard to imagine that any attempt to reduce federal outlays and shrink the size of the budget deficit will be credible if it does not address the issue of government contracts that pay extraordinary profit margins."

BioThrax may just be the tip of the iceberg. Richard C Loeb, a former deputy administrator of the Office of Federal Procurement Policy, whose tenure in that office extended across four presidents, says that he has seen government contracts with even higher gross margins. (By contrast, a 2009 study (pdf) of 6,000 Army and Air Force contracts by the Institute for Defence Analysis found that normal margins on such contracts were typically around 10% of production costs.)

Indeed, there used to be laws in the US to make sure that the government knew what a product cost, so that it could determine reasonable profit margins. The Truth in Negotiations Act (Tina), which was signed into law in 1962, required that companies seeking a negotiated government contract submit "cost and pricing" data.

Unfortunately, Tina did not require cost and pricing data for so-called "commercial" items, which were defined as items sold to the general public in substantial quantities. Government contractors lobbied to have the definition of "commercial" significantly broadened, so that, today, no one really knows how many high margin contracts the government is on the hook for.

BioThrax is considered a "commercial item" – despite the fact that consumers cannot buy it on the open market. Originally developed by military scientists at Fort Detrick, Maryland, in the 1960s, the state of Michigan public health service obtained a licence to produce the vaccine in 1970. At the time, BioThrax was used to help protect mill workers in the textile industry who processed animal hair contaminated with naturally-occurring anthrax.

In 1998, the state of Michigan sold off the facility for an effective cash price of $2.25m – including 28 buildings containing 250,000 square feet of floor space; 59 acres of land and the government licence to manufacture BioThrax.

Today, it has become very clear that BioThrax is both old and very inadequate. A 2002 review of the vaccine by the Institute of Medicine concluded that BioThrax caused swollen arms and muscles, as well as joint pain. According to some campaigners, it may even have resulted in the death of some individuals.

The new owners, which are now a publicly-listed company named Emergent BioSolutions, have three in-house and 24 contract lobbyists. (Lilly explains that, to put Emergent's lobbying in perspective, one might compare it with Merck, one of the most heavily represented companies in Washington, with close to 40 registered lobbyists. To have the same ratio of lobbyists to revenues as Emergent, Merck would have to hire more than 4,000 additional lobbyists.)

Merck sells nearly 100 separate products. Emergent, by contrast, has just one commercially successful product. And the company lobbyists have worked hard to quash any ideas of an alternative to BioThrax, such as one developed by a California-based biotechnology company called VaxGen.

Lilly says that Emergent pounded VaxGen with a highly orchestrated campaign to overstate the problems and discourage government support of the effort. A 2007 investigation by the Los Angeles Times, published under the headline, "New Anthrax Vaccine Sunk by Lobbying", concluded: "The episode illustrates the clout wielded by well-connected lobbyists over billions in spending for the Bush administration's anti-terrorism programme."

Emergent was contacted and asked to comment on Scott Lilly's analysis. In its response, the company argued that it assumed substantial risk for the development and manufacturing of the vaccine and that the price "was based on independent negotiations with two agencies of the US government", both of which "determined the price to be fair and justified". Emergent also contends that it is inaccurate to refer to BioThrax as "old and inadequate"; it argues that the FDA has reaffirmed that BioThrax is a safe and effective vaccine.

Emergent also disputes the Los Angeles Times account of the fall of VaxGen, stating that it did not play "any role in the government's determination that VaxGen failed to meet its contractual obligations". Emergent claims that it "consistently reinvests in appropriate vaccine and therapeutic technology to address government stated national security risks".

Government watchdog groups, however, say that the BioThrax case exemplifies why a major overhaul of government contracting laws are urgently needed. "In the end, prices are jacked up because the cost data isn't transparent, and the government is the loser," says Danielle Brian, the executive director of the Project on Government Oversight. She points out that even system parts of military planes are often classified as "commercial" items.

Taxpayers will continue to be taken to the cleaners unless the government changes the rules on what is deemed "commercial". We need transparency for the government to be able to negotiate good prices and reasonable profits, not concealment.